Reverse Mort

Inverse variety

An inverted mortgage works similarly to a traditional mortgage, but vice versa.
The US Federal Reserve's proposal to enforce repayment obligations for housing finance and their implications for creditors and RMBSs.
On 11 May 2011, the Board of Governors of the Federal Reserve System (the "Board") issued a regulatory proposal1 to implement the repayment provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act"). Observations on the proposal can be sent to the Board of Directors at http://www.federalreserve.

Under the Act, the Truth in Lending Act ("TILA") is amended to prevent lenders from granting mortgages regardless of the consumer's capacity to pay back. Subscription under the Act is broadly similar, but not the same as, the redemption requirement for higher-priced mortgages adopted in July 2008 under the Home Ownership and Equity Protection act2 ("HOEPA").

Contrary to the HOEPA rules, however, the scheme does not limit itself to higher-priced mortgages or credits guaranteed by the borrower's main residence. A wider coverage of the suggested regulation will apply to allhome based retail exposures, main and non-main homes (with the exception of an open line of credit, timeshare scheme, reverse mortgages or transient loans).

In addition, the proposal (i) transposes the limitations of the law on advance payment penalty; (ii) obliges creditors to keep proof of compliance with the rules for three years after a grant of a credit; and (iii) sets benchmarks for meeting the repayment obligation. Legislation forbids a creditor from granting a home credit unless the creditor makes a sound and bona fide decision on the basis of verifiable and documentary information that the debtor will have a sound capacity to pay back the credit.

Firstly, a borrower can fulfil the general repayment standards by initiating a mortgaging operation for which the borrower takes into account and reviews the following eight unwritten elements in order to determine its repayment capacity and for which the computation of the mortgages payable is made on the basis of a fully indexed interest rate: i) actual or reasonably anticipated earnings or wealth; ii) actual job title; iii) actual cash flow from the mortgages; iv) actual cash flow from a concurrent borrowing; v) actual cash flow from the mortgages; vi) actual liabilities; vii) actual borrower's indebtedness; and viii) actual financial histories.

Secondly, a creditor may establish a "qualified mortgage" which provides specific immunity from legal liabilities (a "qualified mortgage"). However, the Board of Directors noted that the law is not clear whether this safeguard should be a "safe haven" from the recovery capability requirements or merely a "rebuttable presumption of conformity " suggesting two alternate avenues.

Alternatively, it functions as a legally secure haven and will define a qualifying mortgages as one in which (i) the credit does not include adverse amortisations, pure interest rate repayments or ballon repayments or a repayment period of more than 30 years; (ii) the aggregate score and charges do not exeed 3% of the aggregate deposit amount;

iii ) the borrower's earnings or asset are reviewed and recorded; and iv) the subscription to the security is (a) predicated on the highest interest rates during the first five years; b) using a repayment plan that repay the entire principal over the life of the borrowing; and c) taking into consideration all senior debt covenants.

Another amendment constitutes a refutable presumption of conformity and redefines a qualified mortgages as including the safety port option and the following supplementary criteria: i) the borrower's job position; ii) the amount paid each month for a concurrent borrowing; iii) the borrower's short-term indebtedness; iv) the overall indebtedness; and v) the borrower's historical record.

Third, a lender may fund a "non-standard mortgage" into a "standard mortgage" (i.e. one that does not involve adverse amortisation, pure interest rate payment or ballon payment and has finite points and fees). The aim is to promote optimised refinancing aimed at quickly refinancing a debtor from a high-risk mortgages into a more robust commodity.

Using this policy, the creditor does not have to check the borrower's salary or asset. Fourthly, a small creditor working predominantly in remote or under-served areas can take out a qualified mortgage with balancing moneyayment. It is an eligible facility for joint ventures that grant interest cover in the form of interest rates on interest rates on ballon lending by allowing such creditors to grant a qualified ballon mortgage provided that the repayment period is five years or longer and the amount is calculated on the basis of planned periodic instalments (excluding ballon payments).

For a number of reason, the suggested rules will radically alter the playground for private mortgages providers. Extent of responsibility. There is considerable responsibility for granting a credit that does not comply with the suggested rules. The transferee of such credits may also be held liable. TILA has extended legal redress in place, in complement to the normal TILA redress, and the Prosecutors General are entitled to file claims for breaches of the repayment rules for a three-year term.

Failure to comply with these solvency rules may also result in a creditor being unable to exclude a defaulter. Contrary to previous repayment capacity requirement, as described above, the field of application of this suggested regulation is very wide and covers all private mortgages. Safety harbour versus rebuttable presumption. Given the significant risk of possible liabilities for non-compliance, a secure haven for qualified mortgages will therefore be very appealing to lessees and assignors of these mortgages (including buyers of entire credit portfolios and RMBS investors).

Qualified mortgages may be defined as the volume of all mortgages from the United States. Extent of delineation and difficulty in measuring adherence can have a significant effect on the accessibility and pricing of mortgages for all kinds of borrower.

An ill-defined and poorly developed standard with standards that are hard for due diligence companies to quantify would be a major blow to the mortgages sector and thus also to prospective lenders. Within this framework, the extent of what makes up "points and fees" and whether a certain relationship between debts and incomes should be established is incorporated.

Any of these definitions will have a significant effect on the sector. In addition, there is an important question that must be addressed in the definitive rules: whether meeting the qualifying mortgage criteria has been treated by Congress as a safer haven from the repayment obligation (a much better standard for lenders) or merely as a supposition of adherence that can be refuted by the borrower.

In the case of a secure harbour, the creditor would only be held responsible if (i) the debtor could demonstrate that the credit is not a qualified hypothec and (ii) the creditor could not demonstrate that the credit fulfils the capacity test for repayment. By accepting the adherence option, the Mortgagor can refute the assumption of adherence by proving that the Term Loan did not pass the Capability Test.

Although the Board of Directors has prepared the proposal, responsibility for the preparation and implementation of the definitive arrangements will pass to the CFPB on 22 July 2011, when the observations are due. One of the first roles of the CFPB will be to develop a definitive regulation, and it is hard to forecast at this point how the CFPB will work.

Specifically, it will remain to be seen whether the CFPB will accept the Board of Directors' foreground assessment supporting the draft proposal or the spirit of the proposal. QRM compared to QRM. QRM creates a category of mortgages that are exempted from the provisions of the law ("Risk Reservation Requirements").

QRM requests are part of a QRM process, which now has a review period of 1 August 2011 (see our May DecemberPoint "Risk Retention Proposal for Resi-dential Mortgages Comes into Focus "). The law stipulates that the QRM must not be defined more broadly than a qualified hypothec.

Taken together, these two understandings will define the form of the RRMBS and it is important that the understandings match so that the flows of mortgages are preserved and the measurement of regulatory compliancy is simple. Below is a listing of some of the main questions that players in the housing securitisation markets should consider.

Definitions of the qualified mortgages. Both of the options suggested have very different needs. In essence, the demands on the acceptance of a compliant option demand that the creditor bear the same charges as would be necessary in the context of the repayment capability test. It is our expectation that creditors of housing will either comment on the changes suggested or suggest a new way forward.

Impact of the satisfactory definition of the qualified hypothec. It is expected that private home finance providers to assist a genuine "safe harbor" will express their views on adherence to the repayment capability test, providing greater predictability on the question of avoidance of liability in the event of non-compliance. There are two alternate methods suggested by the Board of Directors for calculating the amount of points and charges that can be imposed on a debtor under the qualified mortgages concept.